Co-insurance and moral hazard:Some reflections on deposit protection in the UK and USA

Cartwright, Peter; Campbell, Andrew
September 2003
Journal of International Banking Regulation;Sep2003, Vol. 5 Issue 1, p9
Academic Journal
This paper looks at the provisions for deposit protection found in the UK and USA in order to examine some of the difficult policy issues that such schemes present. It is argued that one of the principal difficulties with deposit protection is that its main aims (consumer protection and the avoidance of systemic risk) indicate that high levels of protection are necessary. However, high levels of protection are seen to raise the problem of moral hazard, where banks and depositors have insufficient incentives to take care in their decision making. The USA has focused on moral hazard from the perspective of bankers' decisions by introducing risk-based premiums. Although this is admirable in theory, it is argued that it is extremely difficult to identify the appropriate premium in practice. The UK has focused its attention on moral hazard as it relates to depositors, and has sought to tackle this by using co-insurance. This paper argues that co-insurance is based upon the premise that consumers are able to make informed decisions about the risks posed by banks, but that this is unrealistic in practice. Furthermore, while coinsurance might, in theory, address moral hazard, it reduces the ability of deposit protection schemes to meet their principal objectives.


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